The Independent Market Observer

12/19/12 – Housing Comeback: Demographic Demand Drivers

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Dec 19, 2012 9:29:38 AM

and tagged Market Updates

Leave a comment

In a previous guest post, Peter Essele pointed out that, on an income basis, housing appears very affordable and that the aggregate price index has tracked quite closely with the sold/for sale ratio. The correlation between the two is quite high, at 0.93, suggesting that they are causally linked, which is certainly reasonable from a fundamental supply/demand standpoint. Peter went on to conclude that these metrics support the continued strong performance of the housing market, although, as more supply has come on the market, the ratio has become less favorable.

After looking at his analysis, I decided to take a look at the demand side of the equation. Just as the supply ratio has a high correlation with prices, so, too, should demand. As a proxy for housing demand, I looked at household formation, since, by definition, a household needs a house. Let’s look at this relationship.

121912_3

The above chart shows the change in housing prices plotted against the change in households, both on a percentage basis. I tried different lag periods and found that three months worked best—that is, three months after household formation occurred, housing prices ticked up. The correlation between this formation and prices is slightly lower than that between the supply ratio and prices, but it’s still high enough to conclude that the demand from household formation will in fact help determine price changes.

The good news here is that household formation is trending upward, which has supported, and reasonably will continue to support, strength in the housing market. Not only that, but there is good reason to expect household formation to continue at higher than normal rates due to pent-up demand. During the Great Recession, many people simply could not afford to set up their own households—some were even forced to move in with others—resulting in a significant decline in household formation, even as the population increased.

I will spare you the detailed development of the pent-up demand, which can be found in a good Cleveland Federal Reserve Bank paper. Suffice it to say that there is a substantial number—in the millions—of households that would have been created in a more benign economy, and it is reasonable to conclude that, as conditions improve, they will be created and require housing.

Both the supply and the demand sides therefore have strong fundamentals, suggesting that the housing recovery is likely to persist and may even strengthen. Although there are certainly offsetting factors, the weight of the evidence is for continued growth.


Subscribe via Email

New call-to-action
Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®